Morgan Stanley Should Cut Fixed-Income Unit by 50%, ISI Says

By Michael J. Moore -
Aug 3, 2012

Morgan Stanley (MS) should cut its fixed-
income trading business in half and use the freed-up capital to
buy back a quarter of its shares, said Ed Najarian, an analyst
at International Strategy & Investment Group Inc.

The firm should cut its so-called risk-weighted assets by
$150 billion under Basel III rules, about twice the reduction it
currently plans, Najarian estimated yesterday in a research
note. The larger reduction and buybacks could double Morgan
Stanley’s stock price to about $27, he wrote.

The bank will continue shrinking its fixed-income trading
unit, cutting risk-weighted assets 30 percent from the third
quarter of 2011 through the end of 2014, Chief Executive Officer
James Gorman said last month. Najarian joined CLSA Ltd.’s
Michael Mayo in saying that reduction isn’t enough.

“With Morgan Stanley stock languishing at about 50 percent
of tangible book value, and down more than 50 percent over the
past three years, we think management needs to potentially
embark upon a more aggressive strategic plan in an effort to
create value for shareholders,” Najarian wrote.

Morgan Stanley fell 3.6 percent yesterday to $13.03 and has
declined 14 percent this year. The stock has dropped 56 percent
since Gorman took over at the beginning of 2010. Najarian, who
has a hold rating on the shares, said the current price “could
prove an attractive entry point for speculative investors.”

Forced Selling

Najarian estimated that Morgan Stanley had about $500
billion of risk-weighted assets at the end of the second
quarter, with the fixed-income trading business accounting for
$305 billion. Morgan Stanley hasn’t provided its risk-weighted
assets under Basel III rules, saying only that its Tier 1 common
ratio was just below 8.5 percent.

The firm probably would incur about $3 billion of pretax
losses from reducing assets at a quicker pace, as it would be
forced to sell some positions at below-market prices, Najarian
said. The cuts would allow the bank to repurchase $12 billion in
stock from 2013 through 2015, enough to reduce outstanding
shares by at least 25 percent, he wrote.

Morgan Stanley could buy back about 13 percent of the
shares by the end of 2015 under its current plan, Najarian
estimated.

He didn’t specify in the research note which fixed-income
businesses would incur the additional cuts. Chief Financial
Officer Ruth Porat said last month that Morgan Stanley would
target structured credit and sub-investment-grade securitization
products in its reductions.

Morgan Stanley management must decide to further shrink the
fixed-income business, as it would be hard for an activist
investor to force the company to do so, Najarian said. About
half of the firm’s shares are held by employees, index funds,
Mitsubishi UFJ Financial Group Inc. and China Investment Corp.,
he wrote.